History Says the Worst is Still Ahead for 2018

Every day Jessica and I spend a solid hour reviewing what we should include in these notes. As we thought through today’s disruption section, today’s exchange went like this:

Me: “We should work US equity volatility into disruption. Stock market volatility can disrupt business models and capital markets just as much as a trillion dollar venture capital fund.”

Jessica: “Did you know that the CBOE VIX Index has only once peaked in February since it was created in 1990?”

Me: “Um… No. Really? Well, there we are.”

Check out the table below, which shows the number of times the VIX has peaked and troughed in a given month back to 1990. You’ll see the outlier Jessica highlighted: February 2016, when the VIX got to 28.14. And in the last 28 years of history, it is the only time the shortest month of the year felt like the longest because US equities were in some level of turmoil. (Recall that was the time when markets became momentarily convinced that a US recession was at hand.)

US equity market volatility is deeply informed by seasonality. The quietest month of the year is December (28% of VIX lows for the year have come here). August and October make up 36% of all high VIX readings on the year, and if you throw in January, the percentage rises to 50%. If volatility were randomly distributed, those 3 months would show only 25% of the highs, of course.

So was yesterday’s close on the VIX of 37 the high on the year? One might argue that the dislocation of the inverse ETF products we dissected yesterday was a one-off event and therefore this February should be an exception to historical norms. Perhaps…

But if there is one thing we’ve learned over many years, it is that trading patterns exist for a reason. Volatility is no exception. August of this year will coincide with the peak of the campaigning around midterm election in the US. It will also be enough time to see the true effects of the recently passed tax reform package on consumer spending and business investment. And it is also a typical month for peak volatility. And if you don’t like the idea of volatility coming during your summer holidays, there is always October, another peak month for market churn.

Bottom line: our central investment theme is that the narrative around US equities has shifted from simple (higher earnings and stable rates) to complex (the effects of tax reform on inflation and interest rates, the direction of the dollar, and uncertainties over stock valuation). Higher volatility is a natural extension of this shift.

Out take: February won’t be the low on US equity volatility for the year.